INFORMAL FIRMS IN SUB-HARARAN AFRICA

ByAly MBAYE and Stephen

GOLUB

I. IntroductionII. Definition and measurementIII. The informal sector: causes and effectsIV. Firm Dynamics and large informal FirmsV. Business networks and cross-Border

TradeVI. Conclusions and Policy implications

OUTLINE

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I. Introduction and major research questions and

findings about informality in Africa

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Definition and measurement Sampling strategy Labor market issues Informal firm dynamics and transition Productivity and growth Informal cross-border trade Access to public services Regulatory framework Policy issues

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II. Definitions and Measurement

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The ILO (ILO, 2002) defines informal firms as: Unregistered Sole proprietorships run operated by

individuals or households Lacking reliable accounts.

The ILO approach has been influential in most empirical studies in Africa

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Problems of previous country-level studies in Africa

Studies lack focus, conflating household, worker and entreprise surveys

Lack of comparability of results (e.g. whether or not agriculture is included)

Inferences are consequently unreliable.

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Informality as a continuum

No single criterion (firm size, registration, tax compliance) enables a clear distinction between formal and informal firms.

Informality usually reflects a combination of characteristics.

Steel and Snodgrass (2008) : « ..There is a continuum of different degrees of formality (in terms of different characteristics such as nature of registration, payment of taxes, management structure, contractual arrangements with employees, market orientation, etc.”

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Informality as a continuum

Benjamin et Mbaye (2009) define 6 levels of informality based on five criteria:

1. Firm Size2. Registration3. Honest and transparent accounts4. The existence of a fixed location5. Access to bank credit

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III. The informal sector: causes and effects

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III.1 Informality and firm productivity

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Relation between Productivity and Informality in Dakar et

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Source: Benjamin and Mbaye (2009)

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Source: Benjamin and Mbaye (2009)

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Source: Benjamin and Mbaye (2009)

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Source: Benjamin and Mbaye (2009)

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Productivity and Informality in Eastern and Southern Africa

Source: Gelb et al. (2009)16

III.2 The Determinants of Informality

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The Incentives to Respect Rules and Obligations

Informality is viewed as choice based on the costs and benefits of formal versus informal status.

Cost of informality depends in part on the costs of sanctions for non-compliance and hence on the effectiveness of the legal system (Kanbur 2009, Gelb et al. 2009, Dabla-Norris et al. (2008)

Benefits of formalization depend on the quality of the business environment Verick (2006) Gatti and Honorati (2008)

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State Failures underly the cost/benefit choice facing firms

Loayza (1996) the magnitude of the tax pressures, labor market restrictions (controlling for GDP per capita).

Friedman et al. (2000) corruption and bureaucracy

Azuma et Grossman (2002) the predatory state which splits the spoils between the ruling elite.

Perry et al. (2007) perceptions of the honesty and competence of public officials.

World Bank (2009) a malfunctioning state undermines “tax morale”. 19

The role of education: improving productivity

Akoten et al. (2006): Key role of access to credit, which is affected by education of managers.

Atchoarena and Delluc, 2001 ; Brewer, 2004 ; Haan, 2006 ; Niser, 2007: Formal education fails to serve the needs of informal actors.

Adams (2002), Haan (2006): traditional apprenticeships of dubious quality are the most common form of training for informal workers. Churches and NGOs try to fill the gap but not very effectively.

Johanson et Adams(2004): education plays a key role in enabling transition from informal to formal sector status.

Nielson, Rosholm et Dabalen (2007): only 4.6% of firms with 10 or fewer employees in Kenya, Zimbabwe and Zambie offer training programs compared to contre 81% of firms with 151 or more workers

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IV. Firm Dynamics and Large Informal Firms

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Feasibility of transitions from informal to formal

Transitions are only feasible for high-productivity firms run by well-educated managers (Gelb et al. 2009), Verick (2006) , La Porta et Schleifer (2008).

In which case, a more favorable regulatory environment can encourage transition.

When the regulatory environment is already favorable, little can be done to facilitate to further transitions until firm productity rises.

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Preferences for informal status (Maloney’s perspective)

Maloney (2004), Perry et Al. (2007) note the lack of transition towards the formal sector, even for productive firms. Rather, there is a reverse transition towards the informal sector by agents who prefer the flexibility of informal sector work.

Benjamin et Mbaye (2009) have found some support for reverse transitions towards informality among large actors, although for different reasons.

Ethnic and cultural traditions in Africa might predispose firms to informal status.

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The importance of big informal firms in West Africa

Documented by Benjamin et Mbaye (2009)

Powerful and rich businessmen operate informally in full knowledge of the authorities.

Their existence is a testimony to the weakness of the state in enforcing its rules.

A few examples from Senegal: Moustapha Tall (controls 36% of the rice market), Serigne Mboup (turnover estimated at $600 million).

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Characteristics of large informal firms

Name of the firm coincides with that of the owner.

Despite large size, firms remain individually or family-controlled.

Manifestly fraudulent accounts. Managers usually uneducated, even illiterate. Frequent scandals involving the largest

players, resulting in failures, wrangles with the government, and imprisonments.

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Comparisons of Imports to Reported Turnover

33%

67%

100%

0%

41%

59%

0%

100%

50%

50%

50%

50%

Import- Export Garagiste Commerce Alimentation Bijouterie divers

Importation > CA Importation < CA

Source: Benjamin et Mbaye (2009)

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V. Business Networks and Cross-Border

Trade

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Business Networks

In Africa, ethnic and religious networks often provide a shadow institutional framework substituting for the state, linking informal operators.

Networks provide credit, market information, dispute resolution, safety net.

Networks are powerful and are both cause and effect of weakness of official institutional mechanisms.

Sometimes cross-border in nature.

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Business Networks: The Example of Mourides of Senegal

Mourides are an Islamic brotherhood that emerged in the 19th century.

Specialized in groundnuts then migrated to cities where they became traders and accumulated capital.

Evolved into a sophisticated global informal trading network centered in informal markets of Dakar (Sandaga) and Touba linking traders in Africa, Europe, the United States and Asia.

Operate outside the control of the state. Touba and Sandaga off limits to the authorities.

Operates through strong bonds of solidarity, shared work ethic, and tacit contract enforcement.

Instantaneous transfer of credit around the world by telephone.

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Cross-Border informal trade Large volume of unrecorded cross-border

exchange in Africa (Golub 2009, Golub and Mbaye 2008).

Causes of Smuggling: Porous borders between countries Large differences in import barriers, price controls,

subsidies etc. Ethnic and religious connections that transcend

borders (e.g. Mourides). Weak enforcement and corruption of customs

administration and other state agencies.

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Formal and informal actors in cross-border trade

Trade is carried out by a complex supply chain involving formal and informal firms.

Goods often imported by large official export-import firms who sell to large informal traders who in turn sell to smaller traders.

Large informal firms have government connections or are in the government (e.g. in Nigeria).

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Some examples of informal cross-border trade

Benin to Nigeria: “Re-export” of imported used cars (Golub 2009).

Nigeria to Benin: Smuggling of petroleum products (Golub 2009).

Gambia to Senegal: Re-export of imported sugar (Golub and Mbaye 2008)

Uganda to Kenya: Smuggling of Coffee (Berg 1985).

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The Gambia

2004 2005 2006 2007 Official Exports 2.5% 1.7% 2.2% 2.0% Official Re-exports 1.6% 0.1% NA NA Goods in Transit 2.3% 1.4% NA NA Official Imports 57.1% 51.4% 50.8% 47.4%

Estimated Unofficial Imports for Re-exports 24.1% 18.3% 17.1% 14.3% Estimated Unofficial Re-exports 32.6% 24.7% 23.1% 19.4%

Benin

2004 2005 2006 2007 Official Exports 7.4% 5.1% 5.0% 6.0% Official Re-exports 0.3% 0.5% 0.4% 0.6% Goods in Transit 26.0% 30.9% 44.3% 49.3% Official Imports 22.0% 20.6% 21.3% 26.2%

Estimated Unofficial Imports for Re-exports 22.4% 23.6% 26.6% 32.4% Estimated Unofficial Re-exports 30.2% 31.9% 35.9% 43.7%

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Informal Trade: The Gambia and Benin

VI. Conclusions and Policy Implications

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Conclusions The World Bank (2009) Latin American study

emphasizes that the informal sector must be viewed as a systemic problem of state failure. This is even more true in Africa than in Latin America.

Despite this, there is insufficient information about the nature of the informal sector in Africa.

Informality should be viewed as a continuum. In Africa, the informal sector is the rule rather than the

exception. In Africa, the informal sector is not dominated by

independent microentreprises. It includes large players and organized networks.

In Africa, the informal sector transcends national borders.

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Recommendations: Encouraging Transition of Larger and More Productive Firms to the Formal Sector

Induce larger and more productive firms to transition to formal status by altering the cost/benefit calculus in favor of informality.

Carrots: Improving the business climate, including infrastructure, the fairness of taxation, the quality of business services, the simplicity of regulation, lowering corruption etc.

Sticks: Sanctioning firms that escape their tax and regulatory obligations

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Recommendations: Assisting Weaker Firms

For smaller and less productive firms, full transition from informality is not feasible (Gelb et al 2009). These firms have an important role in employment creation.

Develop appropriate forms of taxation and regulation that do not undermine the viability of these firms.

Improve access to education, training and other business services to raise productivity.

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